A Diagnosis of Venezuela's Suffering Oil Industry

Introduction

Venezuela's oil industry is falling to pieces just at a time when prices have collapsed and the government needs more dollars to avoid what could be the worst economic crisis in the country's history.

In 2015, Venezuela has struggled to maintain output rates to make up for lost dollar revenue while other OPEC states such as Saudi Arabia have cranked up output in an unprecedented bid to squeeze out higher cost supply from U.S. shale oil fields.

While Venezuela has failed to convince OPEC to restore the traditional production curbs that have underpinned oil prices in the past, the country's own failure to pump more oil is a result of years of underinvestment and mismanagement. Despite having the largest reserve base on the planet, state oil company PDVSA is only the 19th largest producer in the world, behind Mexico's Pemex and Brazil's Petrobras, according to information put together by energy group Wood Macenzie.

Venezuela's conventional oil basins in Lake Maracaibo and northeast Monagas state are in rapid decline. While PDVSA and foreign partners such as Chevron and Gazprom have lifted output in the Orinoco oil belt, the gains are in heavy crude oil that needs to be blended with sweet, or lighter crude, before it can be sold on international markets. Sweet crude, once in ample supply from Maracaibo, is now imported from Nigeria.

Venezuela is also suffering from former president Hugo Chávez's long standing agreements to give away cheap oil to Caribbean countries, and loan-for-oil deals with China that reduces PDVSA's revenue in the long run. While President Nicolás Maduro has started to pull back on some of its Caribbean trades including a long-standing supply deal with Cuba, Venezuela doesn't earn full value dollars per barrel on a significant chunk of its total sales.

Venezuela's economy, which is highly dependent on oil, is predicted to contract the most of any country in the world this year. The country will likely default on its sovereign bonds some time in 2016, according to Harvard economist Ricardo Hausman. Hyperinflation is an imminent threat, with inflation running at over 100% this year, according to the IMF.

People line up outside a supermarket in Caracas due to long standing shortages in basic goods. CREDIT: AFP

With Maduro's popularity languishing, Venezuela's troubling economic scenario should entice voters to back opposition candidates in this December's legislative elections. But if Maduro opposes a democratic transition, as he hinted at in a fiery speech in early November, things could quickly spin out of control.

Heightened political turmoil could undermine the government's efforts to bring in more foreign investment into the oil industry, something it has been trying to do since 2013. Venezuela already occupies last place on the Fraser Institute ranking of investment-worthy nations. But should Venezuela improve conditions in its oil industry and offer similar terms to Argentina, Brazil and Mexico - countries that are all making greater efforts to attract oil investment - fortunes could change quickly.

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